How ironic.
Just as half the country is grinding to a halt beneath the snowfall, we hear that the British economy has probably emerged from recession. The Confederation of British Industry reckons that Britain’s economy will have grown by about 0.5% between October and the end of this year. Economists also expect third-quarter growth figures to be revised higher.
At the start of the year, we were looking at falling house prices, plunging stock prices and mass unemployment. Now everyone is shaking the snow from their tin hats, and gingerly asking: “Was that it?”
“No,” is the short answer. Here’s why…
Recession? What recession?
Unemployment growth is slowing. The economy is probably growing again. And the indomitable British shopper has returned. Sent into a panicked feeding frenzy over the weekend as the snow threatened to block access to the shops, British consumers spent £4bn over Saturday and Sunday, reckons the British Retail Consortium.
But let’s take a closer look. For one thing, the retail sales figures were very flattered by last year’s grim performance, as the BRC’s own Stephen Robertson pointed out. And to put it bluntly, retailers are past masters at talking their books. It’s a traditional game played at this time of year. On the last weekend before Christmas, headlines scream about a ‘retail bloodbath’, feeding consumers the idea that there are bargains galore on the high street, and that it’s a buyers’ market out there. Shops are over a barrel, and you can have your pick of the deals. It’s fantastic free advertising for the retail industry. No wonder the post-January sales carnage is never quite as bad as expected.
But 2010 might be different. As my colleague David Stevenson pointed out last week, many retail chains are running out of time. There will be fewer white knights to save stragglers next year. And lenders are likely to become less forgiving as the extraordinary circumstances of 2009 give way to a more ‘business as usual’ attitude.
The heart of the problem
And this gets to the heart of the problem. 2009 was less bad than expected because the Bank of England laid out such a vast safety net. As we’ve pointed out already, low interest rates have kept people in their homes, and tenants in their premises. Meanwhile, banks have hidden the black holes on their balance sheets by allowing commercial property owners much more breathing space on their loans than they normally would.
The trouble is, all of this has to end at some point. People are starting to price in rises in interest rates next year. That’s partly because inflation is being very stubborn, and partly because they genuinely expect to see a recovery.
Now I suspect the Bank of England doesn’t want to hike rates this year at all if it can avoid it. At the back of the Bank’s mind is the fear of deflation. Like most Western central bankers outside of Germany, the Great Depression is the defining event in their philosophy. The mainstream view is that the depression was as awful as it was because the politicians and the bankers didn’t do enough to stop it. They tightened the money supply prematurely. That’s why everything went into relapse mode. The same goes for Japan.
Those are the outcomes that Ben Bernanke in the States and Mervyn King over here want to avoid. We think it’s a bit more complicated than that. You can go back through history and find plenty of occasions when a slump didn’t turn into a rampant depression, despite apparent government inaction (see Bill Bonner’s recent column on the panic of 1920 for example: Do nothing, and order will prevail.)
Indeed, according to Kenneth Rogoff, who’s arguably one of the leading lights on banking crises and the fallout from them, Japan’s experience has been extremely unusual, certainly compared to other post-World War II banking crises. My colleague Jody Clarke interviews Rogoff in this week’s edition of MoneyWeek magazine – he’s well worth reading. If you’re not already a subscriber, subscribe to MoneyWeek magazine.
Why commercial property could sink the UK recovery
But regardless of what you believe is the best way to deal with a recession, the ultimate decision on whether money gets tighter or not may not remain in the hands of the Bank. Commercial banks aren’t going to be in a position to increase lending next year. As the Bank of England points out in its latest Financial Stability Report, banks still have a huge amount of exposure to bad debt in the commercial property sector.
The trouble is, as retailers and other businesses struggle to meet rental payments and the number of empty properties rises, landlords will no longer have enough cash flow to service even the most forgiving loan terms.
“Lenders may be forced into selling a wave of properties as the stock of repossessed assets grows,” reports Graham Ruddick in The Telegraph. The resulting slump in property values could “reduce banks’ recovery rates and could potentially prompt other banks to sell their assets, leading to further falls in property values.” In other words, banks won’t be able to raise enough money to cover their losses. That in turn would leave them less able to lend to the wider economy.
Ex-City trader Riccardo Marzi, in his Events Trader email, reckons that this could be one of the biggest issues of 2010. In fact, there’s a chance that problems with rolling over commercial property debt could even result in a second banking crisis.
So even if the economy’s pulling out of recession, don’t expect a rampaging recovery next year. We could well see a double dip. So where should you invest? Well, our Christmas Roundtable experts give their views in the next issue of MoneyWeek. It’s out on Thursday this week, a day earlier than usual. If you’re not a subscriber, subscribe to MoneyWeek magazine.